The Moral Hazard Problem With McCain's New Plan

The Politico's Victoria McGrane first noticed it:

    Congress' bill - which Holtz-Eakin says provides at least part of the authority McCain would need to carry out his plan - provided a $300 billion program to help distressed borrowers refinance into cheaper Federal Housing Authority mortgages. But to participate, lenders and mortgage investors would have to reduce the mortgage principal, thus taking a loss on the loan.

    Lawmakers argued that the "haircut" would protect taxpayers and mitigate against so-called "moral hazard" that government intervention would encourage lenders to believe they'll always be rescued from their bad business decisions. To make sure homeowners didn't get off scott free either, the law requires them to share any future profits from the resale of their homes with the government.

McCain wants essentially to purchase the mortgages and then write down the principal without a "haircut." That means a loss upfront to taxpayers and more default risk if the house (or housing prices) fall in general.

Says an Obama adviser: "This is a big gift to financial institutions, and the more irresponsible you've been, the more money you'll get from it. It's a bad way to help homeowners, a bad way to recapitalize banks, and it totally ignores the principle I thought McCain and Obama agreed to about protecting taxpayers."